Tech Cash Cow With a Growth Kicker

12/13/2010 3:23 pm EST

Focus: STOCKS

Jocelynn Drake

Financial Analyst, Schaeffer's Investment Research

Analog Devices is a rewarding stock that’s not yet getting its due from options traders, writes Jocelynn Drake of Schaeffer’s Investment Research.  

The author of a recent Barron's article (Analog Devices: Growth at a Reasonable Price, Dec. 9) is extremely fond of Analog Devices (NYSE: ADI), noting approvingly that it's unusual for a tech company to pay a 2.5% dividend. The author also reports that ADI is sitting on a big pile of cash—$2.7 billion—and that it's buying back about $1 billion worth of stock.

Furthermore, analysts project the stock price to reach $44 to $49 a share within the next 12 months, a gain of 22% to 36%. "Analog Devices is a cheap stock with strong profits in a growing sector," says David Trainer, president of research firm New Constructs.

Chips for the industrial market account for 45% of sales. However, the automotive segment has grown 34% in the last year and now represents 12% of sales. ADI's other big, growing market is communications, which is 23% of its business. "Potentially improving industrial and continued upside strength in communications could potentially drive upside," says Vijay Rakesh, a chip sector analyst at Sterne Agee & Leach.

"Analog Devices could benefit from broad-based communications and industrial demand in 2011-2012," Rakesh says. "We believe potential catalysts are lining up with a conservative guidance and significant share repurchases."

Contrarian Takeaway:
From a sentiment standpoint, analysts are smitten with the shares of ADI. According to Zacks, the stock has earned 16 "Buy" ratings, compared to just six "Holds" and one "Strong Sell."

On the other hand, options players seem to be skeptical. The International Securities Exchange (ISE) reports that 12 ADI puts have been purchased to open for every one call purchased to open during the past ten trading sessions. This ratio of puts to calls is higher than 82% of all those taken during the past year. Meanwhile, ADI's Schaeffer's put/call open interest ratio comes in at 1.30, as put open interest outnumbers call open interest among options slated to expire in less than three months. This ratio of puts to calls is higher than 79% of all those taken during the past year, pointing to high levels of pessimism.

Technically speaking, the shares have been in a strong uptrend, gaining roughly 20% since the beginning of 2010. The stock continues to rise along the support of its ten-day and 20-day moving averages. This technical strength could shake loose some of the options bears, creating a fresh wave of buying pressure.

[ADI is a strong stock in a strong sector, as investors rush to take advantage of seasonal strength. Jim Lowell recently explained why tech stocks outperform during most winters. Michael Murphy has argued that tech is much too cheap for the current economic climate—Editor.]

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